There’s been a rebound for Class A and A+ office properties. This comes after office reached bottom in 2023, with Colliers calling the asset class a “leader in year-over-year sales gains.”
However, that is the bright side. The shadier one showed up in the fourth quarter of 2024. According to MSCI, U.S. office vacancy rates reached a high of 19.7%. That is an average, and “there remain pockets of strong demand for high-quality, well-located assets.”
For properties outside of those pockets of strong demand, work on upgrades or redevelopment is likely necessary to make them marketable. MSCI said historical evidence supports the claim that office developments deliver stronger performance than stabilized properties. However, it found that the most effective change comes from acquiring assets, developing or redeveloping them, and then quickly selling them, not holding and operating the property.
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MSCI used public-market-equivalent (PME) analysis to make the determinations. PME involves comparing benchmark property-level returns against a public index. It considers cash flow timing during the life of the investment, which is well adapted to measuring investments with irregular inflows and outflows, like developments and conversions. If a PME is above 1, then there is outperformance compared to the referential. A PME below indicates underperformance.
It used 13,703 properties relative to each asset’s returns in the MSDI U.S. quarterly property index.
Some tendencies helped indicate a more likely performance. For example, acquisitions that happened during higher market strength tended to generate stronger PME. From 2004 to 2007, office PME fell from 1.09 to 0.87. As vacancy rates grew to their highest and deal volumes fell, PMEs expanded. Interestingly, when vacancies were low, price growth was strong, and deal volumes were also strong, investors were more likely to overpay for assets. One lesson is to acquire office properties as close to the highest vacancy rates as possible.
Another improvement to PME is active management. When acquired specifically for development, offices outperformed stabilized assets. Projects and redevelopments had respective PMEs of 1.24 and 1.23. Stabilized office assets had a lower PME of 1.06 relative to their property-type benchmark in the MSCI U.S. Quarterly Property Index, across all assets, strategies, and vintages since 1999.
The more “purposeful” was the execution of higher returns, said the research. “Assets initially acquired in a stabilized state and developed as an afterthought or out of necessity later in their life cycle yielded a PME of 0.94 compared to 1.06 on non-developed, stabilized assets,” It wrote.
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